Generally, a primary goal of the financial industry relates to obtaining better methods for analyzing current/historic data to correlate a present/future value for financial instruments. More specifically, financial data analysis often entails examining past performance data in order to predict future performance. One exemplary type of analysis is used to determine a valuation metric that assesses a risk/reward ratio between current stock valuations and current bond valuations. The valuation metric provides a way to quantify whether the stock market is over or under valued, as compared to current interest rates associated with bonds. From this determination, it is possible to determine a relative value, as a valuation metric that is associated with a risk level of bonds, as opposed to a risk level of stocks. An investor may ultimately utilize the valuation metric to evaluate how their current financial portfolio is distributed between various financial instruments, with respect to their individual risk tolerance (i.e., whether based on the current state of the financial markets, their financial resources would potentially provide a better if they held more stocks than bonds).
A conventional valuation metric is based on a comparison of the 10-year US Treasury note and the forward operating earnings per share average for the Standard & Poor's 500 stock index, which is widely known as the Fed Model (although the United States Federal Government has not officially adopted the metric). Essentially, the Fed model is a valuation metric that quantifies when the forward earnings yield on the S&P 500 is less than the yield associated with a 10-year bond. As such, the Fed model valuation metric is a tool that may be used to determine how to distribute assets within an investor's portfolio.
However, the Fed Model has at least one major flaw—even though the forward earnings yield of the S&P 500 is factored in to the model, the Fed model does not directly account for growth of stocks in determining a valuation. Accordingly, the Fed model does not account for future growth, which is one of the primary advantages of investing in stocks.